The Lehmann Letter ©

Today’s Wall Street Journal has a lead article on commodity prices and inflation:

Investors are concerned that rising commodity prices will boost inflation throughout the economy. In the past soaring inflation squeezed profit margins and thereby generated a stock-market retreat.

But today’s commodity-price surge may not lead to overall inflation and stock-market decline.

In past business cycles, such as the inflationary surges in the early and late 1970s, booming demand here at home – driven by robust borrowing and spending – pulled prices upward. Commodity prices led the charge higher, but that was in response to hyper-strong demand here at home.

Now borrowing, spending and demand are weak here at home. Strong demand in China and other emerging markets is responsible for rising commodity prices. That could affect us in two ways. First, prices on our imports of Chinese finished goods may rise, contributing to domestic inflation. Second, the general rise in commodity prices could boost costs for our producers. But neither of these scenarios for potential inflation find their way around the boulder in the road: Weak demand here at home. That’s why rising commodity prices are not now reminiscent of past inflationary surges.

That doesn’t mean there is no potential trouble down the road. It does, however, mean there’s no automatic connection between the surge in commodity prices and escalating inflation in our own economy.

Tomorrow’s letter will discuss the implications of commodity inflation on profits and the stock market in a weak non-inflationary economy.

© 2010 Michael B. Lehmann